Dividend stocks have been highly fashionable for about five years, as stock market volatility has shaken investor confidence and as rock-bottom rates at the U.S. Federal Reserve have slashed yields across the board. But there is a fundamental misunderstanding among investors that dividend stocks are inherently safe. They are not. Here are three big risks in dividend stocks that most investors either aren’t aware of, or that they are simply ignoring at their own peril:
1. Low Volatility Works Both Ways: Last year, the stock market went like gangbusters with 30% gains for the major indices. However, dividend stock funds such as Vanguard Dividend Appreciation ETF (VIG) or the T. Rowe Price Dividend Growth Fund (PRDGX) only were up about 25%. 2. Low Volatility Is Not Low Risk: Even worse than broad-based dividend funds has been the performance of the Utilities SPDR (XLU), an ETF that focuses wholly on dividend stocks in the utility sector. In 2013, the fund was up a measly 13% including dividends vs. the 32% gain for the broader stock market. 3. High Dividend Is Not Always High Return: There’s an old joke among investors who chase yield: The easiest way for a stock to see its dividend yield double is to watch its share price get cut in half overnight.